WASHINGTON (HedgeWorld.com)--Sixteen months after the Securities and Exchange Commission voted 3 to 2 to adopt new rules requiring most hedge fund managers to register as investment advisers, the two dissenters are still showing signs of frustration with the way things turned out.
Paul S. Atkins, speaking on Feb. 28 to a conference of investment professionals put on by the Investment Adviser Association and the weekly IA Week newsletter, said the SEC is discovering just how much work is involved in requiring thousands of additional fund managers to register. According to a transcript of the speech, he said that despite a shift by the SEC's Office of Compliance Inspections and Examinations from a regular five-year exam cycle to a risk-based monitoring approach, the influx of adviser registrations is stretching SEC resources, to the possible detriment of investors.
Additionally, Mr. Atkins told the conference, the registration mandate caused other, perhaps unintended consequences. Some hedge fund managers extended their lock-up periods to two years to take advantage of a loophole in the rules designed to exclude private equity managers, which typically have longer lock-ups than hedge funds, from having to register. This lock-up extension, which he said was entirely predictable, also is potentially detrimental to investors. Commissioner Cynthia Glassman the other "no" vote on the hedge fund rules, echoed those same sentiments a week earlier in a speech in London.
Still other hedge fund managers haven't registered at all, waiting instead for the resolution of a court challenge to the new rule before deciding whether to sign up. It's a potentially risky strategy, but risk is not always a deterrent in the hedge fund industry.
"It is not an understatement to say that mandatory hedge fund adviser registration vastly expands the workload of the SEC. . . ," Mr. Atkins said. "We are discovering it is no small task to refocus a portion of our examination staff so that they can effectively inspect hedge funds."
Part of the problem is the sheer complexity of some hedge funds. While hedge funds tend to share many attributes with traditional managers--conflict-of-interest issues, custody and recordkeeping, for example--hedge funds' holding structures tend to be more intricate, the funds tend to trade more often, they frequently use leverage and their securities can sometimes be hard to value, Mr. Atkins said.
The SEC also has recently discovered that its Form ADV doesn't capture all the information necessary for a risk-based assessment system to work as well as it should, Atkins told the group. Among the suggestions for addressing this particular issue is increasing the amount of information the SEC collects by requiring quarterly filings. Since there's no way to strictly identify "hedge funds" on the ADV form, such a program would likely apply to most registered investment advisers. "Would it not be ironic if the hedge fund rule increased the regulatory burden on non-hedge fund advisers, as well?" Mr. Atkins asked.
During his speech, Mr. Atkins laid out what may be his main beef with the new hedge fund rules in language that would have made anyone in the room who hadn't been paying attention sit up and take notice. Doubtless that among those who approve of the new rules, he said, are fund managers who believe the SEC will be distracted enough by the challenge of its new enforcement mandate that they might be able to get away with things they might not have before.
"Because of this complexity, and the resulting diversion of staff resources, the new registration requirement could greatly impair our ability to oversee other investment advisers, whose activities are of much greater consequence to the investing public, based on sheer numbers of investors alone," Mr. Atkins warned. "We have seen time and again over the years just how difficult it is for any examiner or auditor to ferret out fraud at large and small retail-oriented investment advisers using straightforward long strategies.
"Some advisers might view the registration of hedge fund advisers as a good thing. After all, by swelling the ranks of registered advisers, the rule has lowered the likelihood that any one registered adviser will be examined by the SEC," he continued. "Because hedge fund advisers are the SEC's 'flavor of the day,' perhaps other advisers are confident that they will avoid SEC scrutiny."
Although Mr. Atkins issued the standard claim at the start of his speech that his views were his own and not those of the SEC, as a direct representative of the commission--and the rulemaking arm of the commission, at that--he couldn't just leave a room full of money managers with the impression that the SEC's enforcement staff would be too busy to pay attention to them if they decided to commit some small-time fraud. He quickly promised that the SEC would not focus all its attention on hedge funds.
But the glass-half-empty implications of what he said must have been clear to everyone there. More advisers to review, plus a goal of stamping out hedge fund fraud could equal a free pass--at least for a while--for opportunistic traditional managers inclined to bend the rules, provided they don't draw too much attention to themselves in the process.
Mr. Atkins also pointed out that despite the registration over the years of thousands of investment advisers, and an active review program, the SEC failed to detect on its own late trading and market timing schemes at mutual funds. "Disgruntled investors," "former employees," or suspicious third parties like prime brokers pointed the way there.
And yet many advisers already feel the burden of the SEC's search for information. Mr. Atkins said respondents to a Securities Industry Association survey reported an average of 231 regulatory inquiries a year. "Yes, two hundred and thirty-one," he repeated. The costs to investment advisers of meeting these requests is measured not just in the hard dollars associated with hiring staff to handle them, but in diversion of time away from managing assets in order to provide the information, a cost that is hard to quantify.
Mr. Atkins acknowledged a perception that the SEC lacks internal coordination, particularly when it comes to "sweeps" conducted by OCIE. Although such sweeps often yield "valuable insights," Mr. Atkins said, separate sweeps initiated by the SEC's headquarters in Washington and its regional offices sometimes overlap, subjecting advisers to multiple, simultaneous sweeps. Compounding the problem, he said, the firm might also be in the midst of one or more Self-Regulatory Organization exams. "Far from cooperating, the various regulators might actually be competing with one another for the regulatory glory. . . . You would cringe if your firm operated in such a fashion."
At least two legislators have. Reps. Vito Fosella (R-N.Y.) and Michael Castle (R-Del.) introduced legislation to abolish the OCIE and fold its duties into existing divisions at the SEC.
Seeking to end his prepared remarks on an up note, Mr. Atkins said the SEC was listening. OCIE, he said, is working on improving coordination and has promised that commissioners will be able to review sweeps before they start. "The bill has given us some important things to think about and a challenge to act," he said. "The concerns expressed by those who are overwhelmed by these exams have not gone unheeded."